Economy refuses to quit booming

Fears of higher interest rates surface as GDP grows by an unexpectedly strong 5.2 percent in the second quarter.

WASHINGTON -- The supercharged U.S. economy did not cool off as expected in the spring but instead grew at an even faster 5.2 percent rate, propelled by strong business investment and government spending, the government reported Friday.

The Commerce Department's first look at the gross domestic product -- the broadest measure of economic health -- for the April-June quarter prompted President Clinton to hail the "vigorous" economic performance during his two terms.

Wall Street, however, worried that the stronger-than-expected growth will increase the likelihood that the Federal Reserve will raise interest rates for a seventh time when Fed officials next meet Aug. 22.

The Dow Jones Industrial Average lost 74.96 points to close at 10,511.17. The technology-heavy Nasdaq Composite Index lost 179.23, extending Thursday's 145-point slide and bringing the week's loss to 431 points or 10.5 percent. The Nasdaq's slide was its third-biggest weekly loss ever and largest daily decline in two months. The Nasdaq has lost 10 percent year-to-date, while the S&P 500 has dropped 3.4 percent and the Dow 8.6 percent.

The new GDP report confounded the economic experts, who had widely forecast a slowing of growth in the second quarter based on a belief that the Fed's previous rate increases would cut into consumer spending, which accounts for two-thirds of total economic activity.

Revised figures showed the GDP grew at an annual rate of 4.8 percent in the first three months of this year, and economists were forecasting that pace would slow to around 3.7 percent in the April-June quarter.

Consumer spending did slow significantly in the second quarter, decreasing to an annual rate of 3 percent, compared to a 17-year high of 7.6 percent in the first quarter.

However, this decline was more than offset by a pickup in business investment in computers and other equipment, which climbed at an annual rate of 19.1 percent. Additionally, businesses upped their spending on inventories, in part to replenish depleted stockpiles.

"The big slowdown in consumer spending was offset by a boom in capital spending," said Allen Sinai, chief economist for Primark Economics in New York. "This was not a soft-landing report. We still have a booming economy."

The Fed, concerned that the lowest unemployment rates in three decades would trigger inflationary wage demands, started raising interest rates in June 1999 to slow activity to a more sustainable pace and keep inflation from becoming a problem.

And the new report did contain good news on inflation. Despite the strong growth in the spring, inflation pressures actually moderated. A price measure tied to the GDP rose at an annual rate of just 2.3 percent in the second quarter, even better than a 3.5 percent rate of increase in the first quarter.

Some analysts said they believed the absence of inflationary pressures would allow the Fed to remain on the sidelines at its August meeting, awaiting evidence that the combined impact of the six rate increases so far has started to slow growth.

"The heart of the issue is productivity, which seems to be so strong that it is offsetting any inflationary pressures," said Oscar Gonzalez, economist at John Hancock Financial Services in Boston.

Analysts said the big increase in business investment in computers and other productivity-enhancing devices should provide assurance to the Fed that productivity increases will continue.

Economists' efforts to predict quarterly movements in GDP were complicated this month by the government's annual revisions of past data. Those revisions left the annual GDP increase at 4.2 percent in 1999 but revised upward the gains in 1998, from 4.3 percent to 4.4 percent, and in 1997, from 4.2 percent to 4.4 percent.

The revisions also changed the pattern of quarterly movements with the fourth quarter of 1999 now shown as growing at a remarkable annual rate of 7.3 percent, the best performance in nearly 16 years, while the first quarter was revised down to 4.8 percent from 5.5 percent.

The strength in the second quarter occurred despite the fact that America's trade deficit widened significantly, subtracting 1.5 percentage points from growth.